September 14th, 2014
by Saxo Capital Markets
On September 18, Scottish voters will be asked the question: "Should Scotland be an independent country?" Financial markets have barely battered an eyelid, but that's likely to change as the vote draws nearer.
What does this mean for traders?
- The currency and bond markets are not currently pricing in a victory for the 'Yes' vote.
- Implied volatility - a foreign exchange measure of market risk - is still languishing below historical norms.
- There is little fear among investors of a sovereign breakup with UK government bonds outperforming treasuries.
- With no precedent to this Scottish referendum, however, market behaviour in the build up to and fall out from September 18 could prove tetchy and over-responsive.
Prepare for the unexpected
Sterling (GBP) has been weakening against the euro (EUR) and US dollar (USD) recently, although how much of that is due to the referendum is open to debate.
There seems to be a creeping unease in markets. A shock victory for the 'Yes' vote, which is not being priced in, could prove to be very messy for markets.
The latest YouGov polls suggests that Scotland will remain part of the union with 51% expected to vote 'no'. That's not much wiggle room if market sentiment has gauged this outcome incorrectly.
Likely outcomes of a 'Yes' vote:
- The existence of a United Kingdom would be called into question, shaking Britain's place as the top table of the UN and the G7.
- Edinburgh and London will likely dispute what is defined as "independence", potentially leaving sterling (GBP) in limbo - with serious consequences for UK financial instruments, as well as FX markets.
- Currency volatility may spike with traders flocking to the US dollar (USD), although the euro (EUR) will likely benefit too.
- Debt is an issue; a decision remains to be made on how much debt Scotland would take with it, leading to questions over English and Scottish ratings in the sovereign markets - huge upheaval in the bond markets may ensue.
Stock markets might be less volatile than currency markets: Scotland only accounts for circa 2% of FTSE 350 sales, according to recent research from Barclays.
Oil companies, however, could be a different story given the dispute over the rights to the oil in the North Sea.
What happens next?
Alistair Darling, the Better Together chief, and Alex Salmond, Scotland's First Minister, will go head-to-head at the final debate, scheduled for exactly a week before the September 18 polling day.
As the vote draws near, the economic significance of a break-up of the union is becoming a key battleground. Markets, though, are pricing in little if any risk of Scottish independence, so it would send shockwaves through UK markets were it to happen. The fallout for the UK economy could be enormous and send the pound (GBP) into reverse; it would be 'tin-hat time'.
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